The risk characteristics of stock are composed of different elements in the market. For the last ten years, the historical performance of Ford Motor Company can be used to determine the risk factors of the company. The sales growth history of Ford is 1.9%, an EBIT margin of 1.4, 6.8 ROCE history and a ROE of 8.6 (Infront Analytics, 2018). Similarly, the company's history shows that it has been undervalued for the last ten years. Ford's assets are exposed to low-risk factors as indicated by its volatility rate of 7.1 against the international peers' risk of 7.9. In this case, the Infront Analytics (2018) indicated that the risk scores for Ford Motor Company were 7.0 in a score of 0-10, in which 0 corresponds to high risks, whereas ten corresponds to lower risks. The Ford's risk scores showed that the company has lower risk factors than its peers in the market (Infront Analytics, 2018). Consequently, this is a risky asset in the market.
Coca-Cola company's performance in the market for the last ten years shows that the company has been having a higher growth rate (Infront Analytics, 2018). In the same way, the company has recorded high profitability. The volatility of Coca Cola's stock in the market is 9.4, thereby indicating that the company has had lower volatility and faced fewer risks in the market. According to the data analysis presented by Infront Analytics (2018), coca cola's stocks in the market has been undervalued for the last five years. As such, the Infront Analytics (2018) further shows that the Coca Cola's risk score was 9 in the scale of 0-10. In this case, Coca Cola's risk in the market is significantly less than the peers in the industry. In this case, Coca-Cola is a risky asset, even though it faces less threat in the market than its peers.
The risk-return of a 3-mth US T Bill is free of market risks. As such, it is important to note that the 3-mth US T Bill is prone to zero risks in the market, hence the risk-free asset in any portfolio.
To calculate the beta of the stock, we need to get a benchmark. In this case, the reference used is the S&P 500 stock returns from 7th December 2018 to 7Th December 2018. The beta of Coca Cola is calculated using the formula beta = Covariance (stock's daily % change, index daily % change)/variance (index daily % change). The calculated beta using data from Wall Street Journal in the excel function for Coca-Cola is 0.11.
Similarly, the calculated beta for Ford Motor Company was 0.03. I this case, the betas of both stocks move lower than the market as they are both less than 1. However, it means that Coca Cola's share is more volatile than Ford's stocks, hence Coca-Cola further providing an opportunity for higher returns than Ford's stock.
Suppose an investor owns the stocks independently, then adds the risk-free asset, the overall effect will be the reduction in the risk levels of the stock. However, since the bond is risk-free, it will reduce the levels of risks by the same percentage in both stocks. In the same way, the expected return on each stock will diminish by the degree of (product of the risk-free rate expected return and the proportion of the total stock represented by the risk-free rate asset).
The risky asset portfolio recommended for a risk-averse investor will be the Ford Company's stock. In this case, risk-averse investors prefer to invest in companies with fewer risks. Ford's risk measure is 7, which is higher than the Coca Cola's risk score. However, the beta of the two companies shows that Ford's assets have less volatility compared to Coca Cola's assets. The low volatility proves lower market response, hence lower risks.
When held as a complete portfolio, the risk-return characteristics of the first portfolio will be arrived at using the CAPM model. The resulting return of the portfolio under the CAPM model is calculated as the risk-free rate plus the product of the beta and the risk premium. In this case, the risk premium is the difference between the return on the market and the risk-free rate. As it happens, a stock with a higher yield on the market and higher beta tends to have the higher expected return under the CAPM model. In this case, the risk-return for the portfolio containing Coca Cola's assets will have higher yields due to a higher beta and market risk. In the same way, the risk returns for the portfolio containing Ford Motor's assets will be lower due to the lower beta and market risk.
The recommended portfolio for the risk-averse investor is the Coca-Cola assets. The lower risk score of 9 and the higher beta further proves that the yield from Coca-Cola is higher than the return from Ford's stocks. In the same way, the lower levels of risks for Coca-Cola will be more applicable to the risk-averse investor.
Infront Analytics. (2018). Risk Analysis of Ford Motor Company (F | USA). Retrieved from https://www.infrontanalytics.com/fe-EN/30019NU/Ford-Motor-Company/gprv-risk
Infront Analytics. (2018). Risk Analysis of The Coca-Cola Company (KO | USA). Retrieved from https://www.infrontanalytics.com/fe-EN/30312NU/The-Coca-Cola-Company/gprv-risk
WSJ. (2018). Coca Cola Co. Historical Prices. Retrieved from https://quotes.wsj.com/KO/historical-prices
WSJ. (2018). Ford Motor Co. Historical Prices. Retrieved from https://quotes.wsj.com/F/historical-prices
WSJ. (2018). S&P 500 Index. Historical Prices. Retrieved from https://quotes.wsj.com/index/SPX/historical-prices
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